Junk Bond Market Suggests US Will Avoid Recession

(Bloomberg) — Junk bond markets in the United States expect the economy may weaken, but not slip into recession.

It comes as Federal Reserve officials vowed to continue fighting inflation aggressively, even if higher rates raise the risk of a recession. Some strategists and money managers believe that the credit markets are not paying enough attention to how bad the next possible downturn will be.

But for now, investors are voting with their dollars. High-yield bonds rose 5.9% in July, their biggest one-month rise in a decade, and they also rose in August, according to Bloomberg Index data.

Risk premiums for bonds stand at levels not normally associated with recessions. Stocks, junk bonds and other risk markets rose in the second half of July as investors raised hopes that signs of slowing growth would translate into the Federal Reserve easing its plans to tighten money supply.

These signs of slowing growth come from multiple regions. Walmart said last week that shoppers are avoiding expensive goods and focusing instead on buying groceries. AT&T said some customers are late in paying bills. Pending home sales in June fell the most since April 2020, according to a report last week.

In the markets, long-term Treasury yields are in many cases lower than short-term yields, a condition known as reversal, which, if it continues, could signal that a recession is about to occur. Commodity prices saw broad declines this month as well.

The riskier parts of the credit spectrum are also showing some concern. CCC-rated bonds, among the lowest-rated companies, gained 4.95% in July, while BB Securities, the top-tier high-yield category, rose 6.1% on a total yield basis.

But it is not clear whether these signs of trouble will translate into a serious downturn.

“The high-yield market is certainly expanding to a certain level of tension, but it’s not pricing anywhere near stagnation levels,” Michael Anderson, strategist at Citigroup Inc., said in a phone interview.

Between December 1996 and December 2021, there were 28 months when the economy was in recession, according to an analysis by Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors. The average junk bond spread over those months was about 835 basis points, or 8.35 percentage points, based on ICE BofA indices. That spread is currently close to 460 basis points, about the average level of non-recession months, according to his analysis.

Scott Kimball, managing director at Loop Capital Asset Management, said much of the recent contraction in spreads is due to energy debt, which has outperformed the broader high-yield market this year with higher oil prices. This could “skew projected default rates downward for the broader market and, in turn, give investors more optimism for broad-based high yield buying.”

Elsewhere in credit markets:

This week’s MLIV Pulse survey focuses on the outlook for credit markets. Please click the link below if you would like to share your views on returns and spreads. The survey is confidential.

https://bloombergresearch.qualtrics.com/jfe/form/SV_8rf6vUnsdYS3x6C?Source=Terminal

Americas

Meta Platforms Inc, the parent company of Facebook, is preparing to sell its first bond, after asking banks to hold meetings with investors.

  • Goldman Sachs Group Inc. The loan sale volume that finances the purchase of healthcare is a sign of improving demand in the US leveraged finance market.
  • Three-month London interbank dollar rate surged to nearly 14-year high as traders brace for steady rate hikes from the Federal Reserve
  • Investors angry at the rapid collapse of a leveraged loan issued by technology company Avaya Holdings Corp. In June appointed a law firm to examine legal options, regarding what they consider insufficient disclosures during the debt marketing process
  • For deal updates, click here for the New Issue Monitor
  • For more, click here for Credit Daybook Americas

Europe, Middle East and Africa

There were no deals on offer in the European primary market on Wednesday, after a strong reception for three priced deals on Tuesday.

  • Europe’s largest real estate company, Vonovia SE, has set aside at least €13 billion in assets for sale as it looks to reduce debt in the face of rising interest rates.

Asia

Risk aversion hit Asia’s credit market on Wednesday after Federal Reserve officials made hawkish comments overnight about inflation and Pelosi’s visit to Taiwan raised concerns about US-China tensions.

  • China’s Danyang Investment Group only sold a dollar-denominated deal on Wednesday
  • SMBC Nikko Securities says US-China tension could affect the corporate bond market in yen
  • Read more: The importance of Pelosi and Taiwan in bond volatility: John Others

© Bloomberg LP 2022

Leave a Comment